Presented by: Sandra Corredor Moshe Farjoun UIUC - Tel Aviv – York U. The Independent and Joint Effects of the Skill and Physical Bases of Relatedness in Diversification Strategic Management Journal (1998) Presented by: Sandra Corredor

Motivation Relatedness encompasses several dimensions… Choosing a particular dimension of relatedness affects the evaluation of motives and consequences: E.g., disagreement about performance of related vs. unrelated diversification It can help existing firms identify different sources of potential competition and opportunities for diversification Combining different dimensions of relatedness: E.g., firm's expansion using several related resources

Q1. Do they differ in the ways they identify relatedness? Resource relatedness is multidimensional: Skill-based + Physical resource-based (SIC) 1. Physical base performance benefits: * Economies of Scope (Teece, 1982) * Economies of Scale More product-specific than other resources: less industries to which they can be applied 2. Skill base performance benefits: * Learning: two-way transfers of knowledge. * Innovation: 'dynamic reciprocity‘ of relatedness. Learn, transfer and combine knowledge Q2. Independent and Joint effects Q1. Do they differ in the ways they identify relatedness?

Methods Sample 158 (Fortune 500) diversified firms with 90% of sales in manufacturing sector. Skill base of relatedness Human skills required in the industry, as indicated by occupational distributions (survey) Industries with similar skill profiles were grouped in skill-related industry groups. Occupational ratios: occupations in which employees are working rather than the occupation for which they were trained. Physical base of relatedness SIC code When products are considered as close end use substitutes but their underlying transformation processes are different Performance: ROA, ROS, market-to-book ratio, Jensen’s Alpha.

Hypotheses Hypothesis 1a: The level of related diversification as indicated by the physical base of relatedness will be positively associated with financial performance. Hypothesis 1b: The level of related diversification as indicated by the skill base of relatedness will be positively associated with financial performance.

Hypotheses Joint Effects The union of the two bases: when they agree in identifying relatedness between two or more industries (lines of business). →Each base extends the other. Interact in several value-added activities: Institutionalized in organizational routines and procedures (N&W). Learning increases the services derived both from the employees and from the material resources. Hypothesis 2: The level of related diversification indicated by a combination of both the physical and skill dimensions will be positively associated with financial performance.

Two Joint Effects Complementarity effect: similarity in production as indicated by both skills and physical characteristics. Extension effect: the relatedness is broader than indicated by each base alone → relatedness encompasses similarity in production, science and engineering, administration, marketing and service… might also encompass relatedness at end use. Perhaps: Joint effect could also mean that the end use of the combined resources: products dimension in Montgomery & Wernerfelt (1988)?

Results (Q1 = Yes) Industries or lines of business related from one standpoint can be unrelated from another However, they are complementary bases for relatedness. (Q2 = Yes and No) Neither base by itself is associated with strong performance effects. When diversification is related on both the physical and the skill base a strong effect of relatedness on performance emerges. The level of related diversification was not significantly associated with greater-than risk-free returns (Jensen's alpha): Neither of the relatedness ratios (SKILL or PHYSICAL), nor their interaction RATIO (JOINT), was statistically significant.

Some notes… Components perspective If resources are related: that means that they are not diverse?... But diversity is important (Cohen & Levintal, 90)→ we need joint effects of two different resources. Empirical issues: Only diversified firms Also based on SIC diversification measures. Omitted variables: controlling for industry structure, but many firm-level variables were omitted.